Drop in Productivity and Rise in Labor Costs Feed Fears of Inflation

Worker productivity abruptly slowed last quarter while an important measure of labor costs took off, the government said Thursday. The combination threatens linchpins of the nation’s long economic expansion and boosts the odds that the Federal Reserve will raise interest rates when its policymakers meet later this month.

The Labor Department said that productivity--the measure of what workers produce per hour--rose at only a 1.3% annual rate in the April-through-June quarter, far slower than the 3.6% pace of the preceding quarter and slower too than the 1.7% rate that economists had been expecting.

Meanwhile, unit labor costs, or what workers are paid per unit of output, climbed at a 3.8% annual rate, the fastest pace in the last year and a half, the department said.

Fast productivity growth and slow labor cost increases had become the trademarks of the current boom, so much so that many people had expected they would continue indefinitely. Analysts said that if it continues, the reversal spells trouble for the economy.

“These numbers confirm the Fed’s worst fears that inflation risks are rising,” said Mickey D. Levy, chief economist with Bank of America Securities in New York.

“They increase the odds of the Fed raising rates from well under 50-50 to a little over,” said David M. Jones, chief economist with Aubrey G. Lanston & Co., also in New York.

Federal Reserve Chairman Alan Greenspan has issued a series of warnings in recent months that, with the economy continuing to grow and unemployment reaching nearly three-decade lows, it is only a matter of time before wages and then prices take off.

He has portrayed American business’ ability to raise productivity as a bulwark against a damaging wage-and-price spiral, but a bulwark that sooner or later would break.

When a business can turn out more goods with the same number of workers, it can boost sales and profits without raising prices. That helps moderate workers’ demand for higher wages and helps hold down inflation.

“Greenspan has talked a lot about the need for productivity growth to accelerate in order to keep inflation in check,” said Paul L. Kasriel, chief U.S. economist for Northern Trust Co. in Chicago. “Going from 3.6% to 1.3% in the second quarter is just the opposite. It’s a sharp deceleration.”

David Wyss, chief economist for Standard & Poor’s DRI in Lexington, Mass., agreed that the combination of weaker productivity growth and employment cost increases provides the Fed with an “excuse” for tightening, “and I think they’re going to take it.” But he also said he is “not terribly concerned” about the outlook for inflation because, among other things, unit labor costs are still up only 1.4% since the second quarter of last year.

Thursday’s statistics are not the first to suggest that the economy may be starting to wobble after having been in near-perfect balance for several years.

The widely watched employment cost index shows that workers’ wages and benefits climbed at a 1.1% rate in the second quarter, far faster than the 0.4% rate of the first quarter and the biggest gain in eight years.

There may be further signs of wobble later today when the government releases July unemployment and average hourly earnings figures. Analysts said that with the jobless rate already at a spectacularly low 4.3%, any further decline will be widely seen as a spur to new wage increases and swift Fed action.

Analysts were divided Thursday about whether the central bank will actually raise interest rates when its policymaking body meets Aug. 24 or will simply signal a readiness to do so. The Fed raised the so-called Federal funds rate, the rate at which banks make short-term loans to one another, a quarter of a point from 4.75% to 5% on June 30. If the bank does raise the rate again, it would probably be by another quarter-point.

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Times staff writer Stuart Silverstein in Los Angeles contributed to this report.

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Business Productivity

Percentage change from previous quarter at annual rate, seasonally adjusted:

2nd quarter: 1.3%

Source: Labor Department